The SEC’s Investor Advocate has issued a letter to Nasdaq concerning Nasdaq’s Solicitation of Comments regarding certain Nasdaq shareholder approval rules. The comments largely echo the comments of the SEC’s Investor Advisory Committee, which were fundamentally skeptical of the Solicitation. (See this PubCo post.)

The Solicitation addresses the Nasdaq rules that generally require companies to obtain shareholder approval before issuing securities in connection with an acquisition of the stock or assets of another company, a change of control or certain private placements at a price less than the greater of book or market value. It does not offer specific proposals, but rather is intended to foster a dialogue with the public regarding whether these rules – which were adopted in 1990 – should be updated, without sacrificing crucial investor protections. Nasdaq suggests that, over the past 25 years, there have been significant changes in the capital markets and securities laws, including development of various corporate governance mechanisms designed for investor protection, such as requirements for majority independent boards. In addition, in Nasdaq’s view, the increased threat of shareholder litigation may have a salutary effect.

As with the Committee, the IA’s underlying concern was that Nasdaq appeared to be predisposed to ease the rules, not stiffen them, with the result that the rights of investors would be diminished: “we are concerned that the tone of the solicitation seems to invite only those comments that call for the elimination or diminution of investor protections in Nasdaq’s existing shareholder approval rules.” Nevertheless, the IA acknowledged that Nasdaq had “clarified publicly that it intends to take all comments into account….”

In general, the letter indicates that the IA believes that

“many corporate actions that directly and significantly impact shareholders’ interests, including through economic and ownership dilution, should appropriately be subject to shareholder approval. Although some updates to the listing standards may be appropriate, we are not likely to support any final proposal from Nasdaq that raises the percentage thresholds or otherwise significantly alters other aspects of the qualitative listing rules, to the extent that they would result in the reduction of the number of corporate actions currently subject to shareholder approval for Nasdaq-listed companies.

“We are generally concerned that board or committee approval may not be an effective substitute for the approval of shareholders, whose interests would be directly impacted by the potentially dilutive effect of such a transaction. Any potential indirect benefit to shareholders of allowing companies to raise additional capital quickly and inexpensively must be weighed against the potentially detrimental impact of a dilutive transaction on shareholders who would no longer have the right to approve the transaction. Moreover, the deterrent effect of shareholder approval requirements should not be underestimated. Issuers can be expected to be far less likely to engage in actions that would harm investors if they know that such actions must first be subject to shareholder approval.”

The IA was also uneasy about the possibility that these types of rule changes would lead to a “race to the bottom” among the other exchanges: “Significantly, our concerns stem in large part from the recognition that Nasdaq’s shareholder approval rules do not exist in a vacuum, but rather in a highly competitive environment for corporate listings. Any proposal to reduce the investor protections currently afforded by Nasdaq’s qualitative listing standards could exacerbate a troubling ‘race to the bottom’ among listing exchanges in connection with these and other qualitative standards. Our review of exchange rule filings yields numerous examples of exchanges lowering their qualitative listing standards over the last decade. For example, we have witnessed what appears to be a vicious circle, with other exchanges pointing to Nasdaq as the competitor justifying lowering their standards, and Nasdaq citing to competitive pressure from these same exchanges to justify lowering its own standards.”

Although the IA agreed with Nasdaq’s concern about the disparate impact of shareholder approval requirements on smaller companies, in the IA’s view, Nasdaq’s approach to the issue was wrongheaded: the IA contended that “any apparent disproportionate impact of Nasdaq’s shareholder approval rules on smaller listed companies could be better addressed by raising the shareholder approval requirements for the well-capitalized companies listed on Nasdaq’s Global Select Market,” rather than lowering the standards for other tiers.

The IA also recommended that Nasdaq consider the indirect costs of substituting board committee approval for shareholder approval, such as the potential for audit committee overload. (See the PubCo posts here and here.) Moreover, the IA questioned “whether independent directors can serve as an adequate substitute for shareholder approval in transactions that may involve heightened risks to shareholders. Although corporations have taken significant strides to increase the number of independent board members, some have observed instances in which directors met the formal listing standards of independence but nonetheless still had significant ties to the CEO or the company. If directors with personal or professional conflicts of interest can be deemed ‘independent,’ shareholders may take little comfort from the fact that important matters are approved by independent directors in lieu of a shareholder vote.

Finally, the IA recommends that, if Nasdaq is seeking meaningful public comment, it should provide some important information and data, such as historical data regarding rule changes and corporate acquisitions. As it stood, there was insufficient information for interested parties to submit useful comments regarding the potential impact of any new rules on investor protection and capital formation.

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